review2spring2004 - ECON 102 SPRING 2004 REVIEW SHEET FOR...

E CON 102 S PRING 2004 R EVIEW S HEET FOR M IDTERM 2 This is not meant to be a complete list, but is instead a guideline of many of the topics covered for this midterm. Professor Kelly reserves the right to ask questions about material that is not listed here, or that is found in your text but was not covered in the large lecture. Please review your notes carefully, work the practice questions, and take care of yourself physically and mentally in preparation for the exam. If you need additional questions remember to check the website for help: www.ssc.wisc.edu/~ekelly/econ102 T HE C LASSICAL M ODEL Assumptions: - markets clear by price adjustment;- there is a market for labor, loanable funds and each good and service;- all capital, labor and land are being used. Labor Market: Full Employment is achieved by the economy on its own; there is no need for government intervention. In particular, the real wage will adjust instantaneously such that the quantity of labor demanded is equal to the quantity of labor supplied. There is no cyclical unemployment in this model. Remark : In the labor market, households supply labor, while businesses demand labor. The quantity of labor households supply increases as the real hourly wage increases; the quantity of labor businesses demand decreases as the real hourly wage increases. At any quantity of labor, the supply of labor curve shows the opportunity cost of the last worker hired, while the demand for labor curve shows the benefit for businesses from the last worker hired (if this concept is not clear to you, draw the picture depicting the labor market and consider a fixed quantity of labor. What is the real wage at which individuals are willing to work? What is the wage that businesses are willing to pay to hire new workers? What does this imply?) Aggregate Production Function: It shows the total output an economy can produce with different quantities of labor, holding constant land, capital and technology. The principle of the diminishing returns to labor tells us that as the number of workers employed increases, output will initially increase at an increasing rate and then eventually increase at a decreasing rate (we can see this from the shape of the aggregate production function). As the employment of labor increases the amount of capital available per laborer decreases leading to lower productivity for subsequently hired workers. Therefore, as the number of workers increases, the output produced increases but by smaller amounts. Say’s law

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